Will China Break?

Consider the following picture: Recent growth has relied on a huge construction boom fueled by surging real estate prices, and exhibiting all the classic signs of a bubble. There was rapid growth in credit – with much of that growth taking place not through traditional banking but rather through unregulated "shadow banking" neither subject to government supervision nor backed by government guarantees. Now the bubble is bursting – and there are real reasons to fear financial and economic crisis.

Am I describing Japan at the end of the 1980s? Or am I describing America in 2007? I could be. But right now I'm talking about China, which is emerging as another danger spot in a world economy that really, really doesn't need this right now.

I've been reluctant to weigh in on the Chinese situation, in part because it's so hard to know what's really happening. All economic statistics are best seen as a peculiarly boring form of science fiction, but China's numbers are more fictional than most. I'd turn to real China experts for guidance, but no two experts seem to be telling the same story.

Still, even the official data are troubling – and recent news is sufficiently dramatic to ring alarm bells.

The most striking thing about the Chinese economy over the past decade was the way household consumption, although rising, lagged behind overall growth. At this point consumer spending is only about 35 percent of G.D.P., about half the level in the United States.

So who's buying the goods and services China produces? Part of the answer is, well, we are: as the consumer share of the economy declined, China increasingly relied on trade surpluses to keep manufacturing afloat. But the bigger story from China's point of view is investment spending, which has soared to almost half of G.D.P.

The obvious question is, with consumer demand relatively weak, what motivated all that investment? And the answer, to an important extent, is that it depended on an ever-inflating real estate bubble. Real estate investment has roughly doubled as a share of G.D.P. since 2000, accounting directly for more than half of the overall rise in investment. And surely much of the rest of the increase was from firms expanding to sell to the burgeoning construction industry.

Do we actually know that real estate was a bubble? It exhibited all the signs: not just rising prices, but also the kind of speculative fever all too familiar from our own experiences just a few years back – think coastal Florida.

And there was another parallel with U.S. experience: as credit boomed, much of it came not from banks but from an unsupervised, unprotected shadow banking system. There were huge differences in detail: shadow banking American style tended to involve prestigious Wall Street firms and complex financial instruments, while the Chinese version tends to run through underground banks and even pawnshops. Yet the consequences were similar: in China as in America a few years ago, the financial system may be much more vulnerable than data on conventional banking reveal.

Now the bubble is visibly bursting. How much damage will it do to the Chinese economy – and the world?

Some commentators say not to worry, that China has strong, smart leaders who will do whatever is necessary to cope with a downturn. Implied though not often stated is the thought that China can do what it takes because it doesn't have to worry about democratic niceties.

To me, however, these sound like famous last words. After all, I remember very well getting similar assurances about Japan in the 1980s, where the brilliant bureaucrats at the Ministry of Finance supposedly had everything under control. And later, there were assurances that America would never, ever, repeat the mistakes that led to Japan's lost decade – when we are, in reality, doing even worse than Japan did.

For what it's worth, statements about economic policy from Chinese officials don't strike me as being especially clear-headed. In particular, the way China has been lashing out at foreigners – among other things, imposing a punitive tariff on imports of U.S.-made autos that will do nothing to help its economy but will help poison trade relations – does not sound like a mature government that knows what it's doing.

And anecdotal evidence suggests that while China's government may not be constrained by rule of law, it is constrained by pervasive corruption, which means that what actually happens at the local level may bear little resemblance to what is ordered in Beijing.

I hope that I'm being needlessly alarmist here. But it's impossible not to be worried: China's story just sounds too much like the crack-ups we've already seen elsewhere. And a world economy already suffering from the mess in Europe really, really doesn't need a new epicenter of crisis.